Dollar General - Hbs

Dollar General Case

1. Consider the $13.4 million of freight costs. What is the correct (GAAP) method of accounting for these? How did Dollar General in fact originally account for these costs? (Include in your answer a table of the effects on income in any years affected, both before and after tax, of the correct accounting and the accounting they originally used.

The correct GAAP method to account for freight costs is as an expense of Cost of Goods Sold (COGS) that occur at the time services are performed and completed. This is a cost of conducting on-going operations (in-bound supplies, distribution and re-distribution). The freight costs should be expensed as occurred which will be at the time invoice is received and approved for payment. The approval of these invoices concurs that services have been performed.

Dollar General should accrue for these expenses as payables liabilities, of which, they will pay via their cash asset account at the time the payable is due. The payment will be a decrease to cash and subsequent liability.

How in fact did Dollar General handle freight charges?

Dollar General states financial results for the end of January [through and including the 28th]. The freight charges in question occurred on January 28, 2000 and should have been reported in full during this fiscal year [2000].

Dollar General handled (SEC stated) freight charges as follows:

(1) Expense $4M in the next fiscal year [2001] on a monthly basis

(2) $1.3M moved to Dollar General's Misc. Accrued Liabilities Account

(3) $2.7M to bank clearing account

Total Reduction in COGS (from 1-3 above):

The result of the above handling of freight charges would have reduced the COGS and increased Net Income. The effects of this are as follows:

YE2000

Original NI 219.4

Restated NI 186.7

Effects on the COGS, irregardless of tax, are a straight pass-through and have direct increase on NI.

ILLUSTRATIVE:

YE2000 Original Correct Freight Cost Reporting

Total Revenue -- --

Total Cost *** 8 Increase in COGS

GP

Operating Income/Loss: 8 Decrease in Operating Income

NI from Continuing Operations: 219.4 211.4

*** Total Cost / COGS less $8M from improper reporting

TAX:

With the proper reporting of Freight Costs Operating Income / Loss would decrease by $8M (mis-allocated) assuming all other operating costs remained constant. Income Before Tax would decrease, as well as, the tax exposure (Income Tax Expense) due to a lower taxable base.

2. Comparing EPS originally reported above for each year, with restated EPS. Why is the restatement for the year ended January 29, 2001 so much larger than for the other two years? Is the larger size a direct result of the restatement or a “secondary effect?”

Year 2/3/2006 1/28/2005 1/30/2004 1/31/2003 2/1/2002 2/2/2001 1/28/2000 1/31/1999 1/29/1998 1/31/1997

EPS Diluted from Cont. Operations 1.08 1.04 0.89 0.79 0.62 0.21 0.65 0.54 0.43 0.34

As Reported EPS 1.08 1.04 0.89 0.79 0.62 0.21 0.65 0.54 0.43 0.34

EPS Before Restating * 0.62 0.65 0.54

*Note: The EPS must have been restated again after 2002, since the EPS above and taken from the latest Morningstar information, do not correspond to the values given in the Dollar General handout, except for 2001.

Answer: As we see above on the 10 Yr Income Table the year 2001 had an expense in the "Other" row. This $162 million was a pre-tax expense to settle the Company's restatement-related litigation, described in the Dollar General handout. This amount significantly reduced the Operating Income. Also in the 2001 column, notice that